Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

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Wednesday, March 11, 2009

Government Files Information in Madoff Case

Here is the Information filed by the U.S. Attorney in the Bernard Madoff case.  It does not contain much new information about how Madoff conducted his fraud.  It alleges that Madoff's ponzi scheme began at least as early as the 1980s, that Madoff misrepresented that he used an investment strategy known as a "split strike conversion" strategy, but that in fact he made no trades for the investors.  Contrary to other published sources that Madoff promised investors a steady 10% return, the information alleges that he promised investors varying returns and some investors were promised as much as 46%.  Madoff created a large infrastructure to generate the impression that he was engaged in legitimate business activities, including hiring numerous employees to serve as the "back office" and generate the phony account statements and trade commissions.  In addition, from at least 2002, Madoff transferred more than $250 million to the London firm to create the impression he was conducting transactions in Europe on behalf of investors.

As of November 2008, Madoff had about 4800 client accounts, whose account statements reported a collective balance of $64.8 billion.

The Information contains 11 counts, including securities fraud, mail fraud, wire fraud, money laundering and perjury charges, relating to sworn testimony Madoff gave before the SEC in May 2006.  The Information does not name any accomplices.

March 11, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Tuesday, March 10, 2009

FINRA Settles Short-Selling Violations with First New York Securities

FINRA announced that it has fined First New York Securities L.L.C. $170,000 for improperly covering short positions with secondary offering shares and related oversight failures. The firm was also ordered to disgorge more than $171,000 in trading profits earned from the prohibited conduct. Four of the firm's former traders who conducted the transactions were fined a total of $95,000.

During the relevant time, the Securities and Exchange Commission — through Rule 105 of Regulation M — prohibited covering a short sale with securities obtained in secondary offerings when the short sale occurs during a specific restricted period — typically five business days — before the secondary offering is priced.   A FINRA investigation found that in 2005, the firm and four traders violated Rule 105 in connection with five public offerings by selling shares short during the restricted period and then covering their short positions with shares received through the offering. By engaging in this prohibited conduct, the firm and the four traders effectively eliminated their market risk and earned a profit of $171,504.

FINRA ordered Joseph E. Edelman to pay a fine of $50,000 and Larry Chachkes to pay a fine of $30,000. The other two traders — Michael M. Cho and Kevin A. Williams — were each ordered to pay a fine of $7,500.

In addition, FINRA found that the firm failed to adequately supervise the activities of the four traders and failed to establish and enforce a supervisory system and written supervisory procedures reasonably designed to achieve compliance with, and prevent violations of Rule 105.  The firm also was found to have provided inaccurate information in response to an inquiry from FINRA. The communication of the inaccurate information was caused by the firm's failure to have in place adequate supervisory procedures reasonably designed to ensure the firm provided responsive information to regulatory inquiries. The firm also failed to maintain adequate books and records in connection with the subject transactions.

In settling this matter, the firm and the four traders neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

March 10, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

HS3 Technologies Settles Reverse Merger Charges

The SEC issued an Order Instituting Cease-and-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933, Making Findings, and Imposing a Cease-and-Desist Order against HS3 Technologies, Inc. (HS3).  The Order finds that, prior to a November 2005 reverse merger, HS3 was named Zeno, Inc. (Zeno) and ostensibly operated as an exploration-stage mining company, based in Vancouver, British Columbia, Canada. In August 2004, Zeno filed a Form SB-2/A amended registration statement with the Commission on behalf of shareholders seeking to resell restricted shares that they had bought directly from Zeno. In its registration statement, Zeno represented that the sale of shares would occur without the involvement of underwriters, and that Zeno would not receive any proceeds from the sale of these shares. In the November 2005 reverse merger, Zeno merged with a privately-held biotech startup, adopted the startup's business plan, replaced its own management with the startup's management, and changed its name to HS3.

The Order further finds that a stock promotion firm orchestrated the reverse merger as part of an agreement with the biotech startup to take the startup public and raise funds for implementation of its business plan. The stock promotion firm and its associates acted as underwriters for a distribution of shares listed in the Form SB-2/A registration statement by acquiring the majority of the shares listed in the registration statement and selling these shares to a network of investors, transferring $500,000 of the proceeds to HS3, in October 2005. HS3 participated in, and shared in the proceeds of, an unregistered distribution of its shares because the distribution that took place differed materially from the proposed sale of shares that HS3, under its previous name, Zeno, had registered with the Commission. No other registration statements were filed or in effect that applied to the distributed shares, and no exemption from registration applied. HS3 failed to verify whether the distribution of shares and its receipt of proceeds complied with representations made by prior management in the August 2004 Form SB-2/A.

Based on the above, the Order requires HS3 to cease and desist from committing or causing any violations and any future violations of Sections 5(a) and 5(c) of the Securities Act. HS3 consented to the issuance of the Order without admitting or denying the findings. In the Matter of HS3 Technologies, Inc.
(Rel. 33-9014; File No. 3-13404)

March 10, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former CEO and CFO of AstroPower, Inc. Settle Fraud Charges

The SEC filed a settled civil fraud action in the United States District Court for the District of Columbia against Allen Barnett, the former CEO, and Thomas Stiner, the former CFO, of AstroPower, Inc., a manufacturer of solar electric power products. AstroPower is no longer an operating company as its common stock was cancelled and its assets liquidated via bankruptcy in 2004. Barnett and Stiner agreed to permanent injunctions; payment of civil penalties in the amount of $65,000 and $40,000, respectively; and other sanctions.

According to the Complaint, Barnett and Stiner made material misstatements, engaged in fraudulent accounting practices, and signed filings made with the Commission that they knew, or were reckless in not knowing, contained materially false and misleading financial statements. The Commission alleged that at the direction of Barnett and Stiner, and in contravention of Generally Accepted Accounting Principles, AstroPower improperly recognized approximately $4 million in revenues from four transactions executed over the course of the second and third quarters of 2002. According to the Complaint, as a result of improperly recognizing revenue from these transactions, AstroPower's net income was overstated by approximately $160,000 or 80% for the second quarter of 2002, and approximately $440,000 or 113% for the third quarter of 2002. The Commission alleged that these material misstatements of revenue and net income were included in Commission filings that Barnett and Stiner signed.

March 10, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Schapiro on New Era of Responsibility

Excerpts from SEC Chairman Schapiro's speech at 2nd Annual CCOutreach BD National Seminar, Mar. 10, 2009:

At a time when investor confidence may be at an all-time low, the most effective way to raise that confidence, and invigorate our capital markets, is for there to be a "New Era of Responsibility" on Wall Street. Financial services firms need to lead the charge in fixing the problems that exist. As a CCO, you play a leading role in establishing the New Era of Responsibility — you should be empowered to speak out and let it be known that Compliance and Supervision are as important to a successful firm as the Sales and Trading desks. I urge you — as I have done for the past 20 years — to use your positions to build the culture of compliance throughout your firms.

What would this "New Era" look like? For each new challenge, a proactive and comprehensive solution must be formulated. Today, the panelists will be discussing some of their challenges and the solutions that have worked for them. Today's panels will focus on four important topics:

First, The Challenge of Regulatory and Compliance Issues in the Current Economic Environment. Current market conditions have created challenges that firms have not experienced before, and placed greater stress on operational units and on compliance programs. In some cases, you are being asked to do more with less — you have to tighten controls while your budget is being reduced. The New Era could include greater intra-firm coordination to ensure more precise and coordinated internal controls and risk management systems, including additional stress testing, expanded scenario analyses, and strong custody and asset verification controls. The New Era might also include broader, clearer disclosures to investors, stronger policies and procedures, and streamlined systems.

Second, The Challenge of Information Protection and Privacy. Evolving technology creates unique challenges. Every week there are news reports about new methods that hackers are implementing to access confidential and sensitive information. You will hear today how firms have bolstered their information protection and privacy protocols — to address administrative, technical and physical safeguards for both customer and firm confidential information. All of us will have to work harder and smarter in the New Era to ensure that customer and firm information remains safe.

Third, The Challenge of Non-Traditional Investment Products. As securities firms bring new, non-traditional products to the market, they must ensure that the energy put into product development is matched by a focus on ensuring that the product is understandable, understood, and suitable for those to whom it is sold. In the New Era, there will be better disclosures to investors, more careful risk assessment of complex products before they go to market, more training for firm personnel, and more attention paid to the suitability of products.

Fourth, The Challenge of Enterprise-Wide Supervision. Given the number and complexity of financial firm mergers and consolidations in the past year, developing and enforcing compliance programs across a large and diverse organization has become even more challenging. How does a CCO ensure that the staff of each business unit is adequately trained in compliance responsibilities? How does a CCO help to identify and manage the conflicts that may arise between business units? In the New Era, strong controls in conflicts management, information barriers and broader, stronger (enterprise-wide) supervisory systems will be essential.

March 10, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Madoff Expected to Plead Guilty This Week

At a hearing today to consider whether Ira Sorkin, Bernard Madoff's attorney, could continue to represent Madoff despite possible conflicts, Mr. Sorkin told the judge that Madoff is expected to plead guilty later this week to charges that would result in his spending the rest of his life in prison.  The federal prosecutor said that there was no plea deal.  The judge determined that the conflicts were waivable and Mr. Sorkin could continue representation.  NYTimes, Madoff Guilty Plea Expected; He Could Face Life in Prison.

March 10, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Bernanke Speaks on Financial Reform

Chairman Ben S. Bernanke gave a speech today at the Council on Foreign Relations, Washington, D.C. on Financial Reform to Address Systemic Risk:

At the same time that we are addressing such immediate challenges, it is not too soon for policymakers to begin thinking about the reforms to the financial architecture, broadly conceived, that could help prevent a similar crisis from developing in the future. We must have a strategy that regulates the financial system as a whole, in a holistic way, not just its individual components. In particular, strong and effective regulation and supervision of banking institutions, although necessary for reducing systemic risk, are not sufficient by themselves to achieve this aim.

Today, I would like to talk about four key elements of such a strategy. First, we must address the problem of financial institutions that are deemed too big--or perhaps too interconnected--to fail. Second, we must strengthen what I will call the financial infrastructure--the systems, rules, and conventions that govern trading, payment, clearing, and settlement in financial markets--to ensure that it will perform well under stress. Third, we should review regulatory policies and accounting rules to ensure that they do not induce excessive procyclicality--that is, do not overly magnify the ups and downs in the financial system and the economy. Finally, we should consider whether the creation of an authority specifically charged with monitoring and addressing systemic risks would help protect the system from financial crises like the one we are currently experiencing. My discussion today will focus on the principles that should guide regulatory reform, leaving aside important questions concerning how the current regulatory structure might be reworked to reduce balkanization and overlap and increase effectiveness. I also will not say much about the international dimensions of the issue but will take as self-evident that, in light of the global nature of financial institutions and markets, the reform of financial regulation and supervision should be coordinated internationally to the greatest extent possible.

March 10, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Monday, March 9, 2009

Cuomo and Frank Demand BofA Reveal Names of $1 Million Bonus Recipients

New York State Attorney General Andrew Cuomo and Congressman Barney Frank, Chairman of the House Financial Services Committee, sent today a letter to Bank of America CEO Kenneth Lewis regarding bonuses paid to top executives at BofA and Merrill Lynch. The letter demands that BofA immediately disclose individual bonus data for all individuals at Merrill Lynch and BofA who received 2008 bonus awards of $1 million or more.  The letter concludes by stating:

Your refusal to reveal compensation information fuels distrust and cynicism at a most sensitive time.

March 9, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

FINRA Proposes Expansion in TRACE Reporting

FINRA proposes a major expansion of its Trade Compliance and Reporting Engine (TRACE) to include debt issued by federal government agencies, government corporations and government sponsored enterprises (GSEs), as well as primary market transactions in new issues. Currently, TRACE reports real-time pricing and trade volume information only on corporate bonds trading in the secondary market.  Approval of the proposal by the SEC would nearly double the number of bonds included in TRACE reporting. Roughly 25,000 government agency, corporation and GSE bonds would become TRACE-eligible, in addition to the approximately 30,000 corporate bonds now on TRACE. Retail investor activity in the government agency and GSE bond markets is believed to be comparable to retail activity in the corporate bond market.

TRACE was established in July 2002 to bring transparency to the corporate bond market. It was fully phased in by February 2005, offering real-time, public dissemination of transaction and price data for all corporate bond trades — including intra-day transaction data and aggregate end-of-day statistics (most active bonds, total volume, advances and declines and new highs and lows).  Retail investors have free access to this data at the FINRA website.

March 9, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Senior Supervisors Group Releases Report on Management of CDS Activity

The Senior Supervisors Group (which comprises senior financial supervisors from seven countries --United States, Canada, France, Germany, Japan, Switzerland, United Kingdom) today issued a report that assesses how firms manage their credit default swap activities related to the settlement of credit derivatives transactions terminated by the occurrence of a credit event.  This report — Observations on Management of Recent Credit Default Swap Credit Events — summarizes a review that the Senior Supervisors Group initiated in December 2008. The observations in the report are based on discussions with senior members of selected institutions, comprising major dealers, buy-side firms, service providers, and an industry association:

Surveyed participants reported that recent credit events were managed in an orderly manner, with high participation rates and no major operational disruptions or liquidity problems.

March 9, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Charges Investment Adviser Made Up Billion-Dollar Client

The SEC filed a civil injunctive action against Locke Capital Management, Inc., an investment adviser, and Leila C. Jenkins, its founder and sole owner who currently serves as its President, Chief Executive Officer, and Chief Investment Officer. The Complaint alleges that Jenkins invented a billion-dollar client in order to gain credibility and attract legitimate investors. The Complaint further alleges that Jenkins tried to perpetuate her scheme by lying to the Commission staff about the existence of the invented client and furnishing the staff with bogus documents in 2008, including fake custodial statements that she created on her laptop.

Besides the invented client and assets under management, the Complaint alleges several other lies Jenkins and her firm told to investors. These include misrepresenting Locke's performance for years in which Locke had no clients and deceiving clients about the makeup of the firm, including the number, identity, and role of its employees.

The Complaint seeks a permanent injunction against future violations of the securities laws, disgorgement of ill-gotten gains and prejudgment interest thereon, and a civil monetary penalty.

March 9, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Surpreme Court Accepts Cert in 36(B) Excessive Fee Case

The U.S. Supreme Court accepted certiorari today in an important case involving a mutual fund holder's ability to challenge the investment adviser's fees as excessive under section 36(b) of the Investment Company Act.  In Jones v. Harris Associates, 527 F.3d 627 (7th Cir. 2008), a three-judge panel of the 7th Circuit, with Judge Easterbrook writing the opinion, held that investment advisory fees that were comparable to those of similar funds (and not otherwise unlawful under the ICA) were not excessive and specifically disapproved an earlier 2d Circuit opinion, Gartenberg v. Merrill Lynch Asset Management, 694 F.2d 923, as relying too little on markets:  "a fiduciary duty differs from rate regulation."  Judge Posner dissented from a subsequent denial of a petition to rehear the case en banc, 537 F.3d 728.  Professor Bill Birdthistle (Chicago-Kent) filed, on behalf of a group of law professors, an amicus brief urging the Court to accept cert and advises me that he plans to write a merits brief to explore the ramifications of Gartenberg/Harris Associates.

March 9, 2009 in Judicial Opinions | Permalink | Comments (0) | TrackBack (1)

Sunday, March 8, 2009

Mitchell on Public Shareholders

The Legitimate Rights of Public Shareholders, by Lawrence E. Mitchell, George Washington University - Law School, was recently posted on SSRN.  Here is the abstract:

In recent years there has been significant ongoing academic debate over the expansion of public shareholders' participation rights in corporate governance. The debate has accompanied a dramatic increase in institutional shareholder and hedge fund activism attempting to influence the conduct of corporate affairs.

The legitimacy of shareholder participation rights depends upon the actual role public shareholders play in contributing to the corporation's function of providing goods and services and, ultimately, to economic growth and social welfare. Nobody in the debate has stopped to examine this question. This paper presents original empirical evidence that demonstrates that public shareholders do not, on net, contribute capital to finance industrial production, and in fact are net consumers of corporate equity. Moreover, their investment incentives significantly distort the behavior of corporate managers who place strong emphasis on stock price at the expense of long-term business health, a fact that has played some role in the current global financial debacle. The logical conclusion is that public shareholders' rights should, ideally, be eliminated, and certainly not expanded or enhanced.

March 8, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Schwarcz on Financial Safety Net

Too Big to Fail?: Recasting the Financial Safety Net, by Steven L. Schwarcz, Duke University - School of Law, was recently posted on SSRN.  Here is the abstract:

Government safety nets in the United States and abroad focus, anachronistically, on problems of banks and other financial institutions, largely ignoring financial markets which have become major credit sources for consumers and companies. Besides failing to protect these markets, this narrow focus encourages morally hazardous behavior by large institutions, like AIG and Citigroup, that are "too big to fail." This paper examines how a safety net should be recast to protect financial markets and also explains why that safety net would mitigate moral hazard and help resolve the too-big-to-fail dilemma

March 8, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bullard on Money Market Funds

Federally-Insured Money Market Funds and Narrow Banks: The Path of Least Insurance, by Mercer Bullard,
University of Mississippi - School of Law, was recently posted on SSRN.  Here is the abstract:

In September 2008, the Treasury created a temporary insurance program for money market funds ("MMFs"), which had never previously been covered by government insurance. This essay argues that this program should be made permanent. To the extent that deposit insurance is intended to protect cash accounts that provide a stable foundation for our payments system, similar insurance should be made available to MMFs, which serve this function while presenting less risk than bank deposits. The argument that only bank accounts should be insured because the liquidity they create for long-term ventures otherwise would dry up might once have made sense, but it no longer reflects modern financial markets where liquidity creation has become broadly diversified. Deposit insurance also should be made available to bank deposits backed by short-term assets (like MMFs) that would be relieved of burdens to which other bank deposits are subject, such as the Community Reinvestment Act.

March 8, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Roe on Washington & Delaware

Washington and Delaware as Corporate Lawmakers, by Mark J. Roe, Harvard Law School; European Corporate Governance Institute (ECGI), was recently posted on SSRN.  Here is the abstract:

American corporate law scholars have long focused on state-to-state jurisdictional competition as a powerful engine in the making of American corporate law. Yet much corporate law is made in Washington, D.C. Federal authorities regularly make law governing the American corporation, typically via the securities law-from shareholder voting rules, to boardroom composition, to dual class stock, to Sarbanes-Oxley - and they could do even more. Properly conceived, the United States has two primary corporate lawmaking centers - the states (primarily Delaware) and Washington. We are beginning to better understand how they interact, as complements and substitutes, but the foundational fact of American corporate lawmaking during the past century is that whenever there has been a big issue - the kind of thing that could strongly affect capital costs - Washington acted or considered acting. Here I review the concepts of the vertical interaction, indicate what still needs to be examined, and examine one Washington-Delaware interaction in detail over time. Overall, we cannot understand the governmental structure of American corporate lawmaking well just by examining the nature, strength, and weaknesses of state-to-state jurisdictional competition.

March 8, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)